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New Planning
Opportunities with Non-Spouse Rollovers
Before 2007, a
non-spouse beneficiary of a qualified plan was stuck taking
distributions under the terms of the plan, which typically
required full distribution within five or fewer years of the
participant's death. The Pension Protection Act of 2006 (PPA
2006) authorized non-spouse beneficiaries (before it was
only surviving spouses) to roll over to an Inherited IRA.
This issue of The Wealth Counselor looks at a very recent
pronouncement from the IRS that finally makes this PPA 2006
provision useable and, therefore, is very beneficial to
clients and all wealth planning professionals who understand
its implications.
Apparent Good News in PPA 2006
PPA 2006 provides that, effective January 1, 2007, a
non-spouse qualified plan beneficiary may be permitted to
roll over to an Inherited IRA after the plan participant's
death.
The January 2007 IRS Roadblock
Unfortunately, the IRS focused on the "may" and quickly
issued guidance that virtually eliminated the planning
opportunity that PPA 2006 seemed to provide. In its January
29, 2007 Notice 2007-7, the IRS declared that a plan was not
required to offer non-spouse rollovers, saying it was
optional with the plan provider whether to adopt a plan
amendment permitting non-spouse rollovers. Therefore, absent
a voluntary plan amendment, a non-spouse was stuck using the
plan's payout period. And major plan providers did not offer
such amendments to their prototype plans.
The October 2007 IRS Roadblock Removal
In late October the IRS issued its 2007 Interim and
Discretionary Amendments, as follows:
"Section 402(c)(11) [Discretionary]:
PPA '06 . . . added Section 402(c)(11) to allow nonspouse
beneficiaries to roll over distributions from a qualified
plan to an individual retirement plan. Nonspouse beneficiary
rollovers are an optional plan provision for 2007. See,
Notice 2007-7. Pursuant to an impending technical
correction, nonspouse beneficiary rollovers will be required
for plan years beginning on or after January 1, 2008."
(Emphasis added.)
This amendment appears to be in anticipation of a
Congressional change to PPA 2006 to make it mandatory that
qualified plans permit non-spouse rollovers. Read the
full text of the IRS document.
What Does All This Mean for Your Clients?
Beginning January 1, 2008, non-spouse beneficiaries finally
will be able to take advantage of the PPA 2006 provisions
and roll over from a qualified plan into an Inherited IRA.
In the Inherited IRA, the non-spouse beneficiary can use his
or her own life expectancy to determine annual required
minimum distributions (RMDs). This can significantly reduce
the amount that the beneficiary must withdraw each year,
thereby deferring income tax and allowing the account
balance to continue to grow income tax free.
Implementation of a non-spouse rollover raises numerous
pitfalls for the unwary. These pitfalls are identified in
the Planning Tips that follow.
Planning Tip: The transfer must be DIRECTLY
from the plan Trustee to the Inherited IRA's Custodian
or Trustee.
Planning Tip: Any distribution to a non-spouse
beneficiary is a taxable distribution, subject to income
tax. Therefore any check delivered by the plan Trustee
MUST be made payable directly to the Inherited IRA
Custodian or Trustee.
Planning Tip: Unlike with a surviving spouse
rollover, the Inherited IRA must remain in the name of
the deceased participant. The Inherited IRA should be
titled like this: Account Holder, deceased, IRA f/b/o
Beneficiary.
Planning Tip: DO NOT re-title the qualified
plan in the name of the non-spouse beneficiary. That
will be treated as a taxable distribution.
Planning Tip: DO NOT transfer from the
qualified plan to an existing IRA in the non-spouse
beneficiary's name. That, too, constitutes a taxable
distribution of the entire account.
Planning Tip: A non-spouse beneficiary must
begin taking required minimum distributions from the
Inherited IRA by December 31 of the year following the
year of the participant's death. Note: This is different
from a spouse rollover, where the surviving spouse can
defer required minimum distributions until attaining age
70 1/2.
Planning Opportunities
The IRS's change of position means that additional planning
options are now available for non-spouse beneficiaries of
qualified plans. These options include those listed below,
which were outlined in greater detail in a prior issue of
The Wealth Counselor:
- Name a Retirement Trust as beneficiary to ensure the
longest term payout possible, while also ensuring
consistent account management - in the manner desired by
the client using the client's advisors - oftentimes over
generations.
- Give the accounts to charity at death and replace
with insurance owned by a Wealth Replacement Trust.
- Take the money out during lifetime and buy an
immediate annuity to provide a guaranteed annual income,
to pay the income tax, and to pay for Insurance owned by
a Wealth Replacement Trust.
- Take the money out during lifetime and pay the
income tax, then gift the remaining cash through an
Irrevocable Life Insurance Trust or other Irrevocable
Trust.
- Name a Charitable Remainder Trust as beneficiary
with a lifetime payout to a surviving spouse; the
remaining assets passing to charity at the death of the
spouse.
- Give up to $100,000 from IRAs directly to charity
before December 31, 2007.
Asset
Management Opportunities
Experience teaches that beneficiaries often frustrate the
stretch-out plans of the decedent and squander their
opportunity for tax-free growth by withdrawing far more than
the required minimum distributions. However, if the
participant names a trust as beneficiary of the qualified
plan, PPA 2006 provides that the trustee of that trust may
roll over from the qualified plan into an Inherited IRA for
the benefit of the trust beneficiary. Clients who name a
trust as beneficiary of their qualified plan account can
thereby protect the assets from creditors (including loss in
a beneficiary's divorce) and the beneficiary from the
temptation to be a spendthrift.
Planning Tip: Naming a trust as beneficiary
also allows the participant's trusted financial advisor
to continue to manage assets as the participant desired.
Conclusion
The IRS now requires that all qualified plans permit
non-spouse rollovers for plan years beginning on or after
January 1, 2008. This "about face" means that all non-spouse
beneficiaries will be able to roll over from qualified plans
to Inherited IRAs rather than be stuck with shorter payout
under the plan provisions. This will permit the planning
team to implement the right strategy to meet the client's
unique planning objectives.
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